The MCI Project What Message Is Mci Finance Essay
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MCI would like to enhance Shareholder value by repurchasing outstanding stock, and send a bold signal to market and manager to stimulate the market price per stock to increase.
A share buyback (by investing in themselves) instead of paying a cash dividend or, in other words, increasing a regular dividend, could represent an increase in the value of shares still available, this happens in the case that occurs a reduction in the number of shares of stock outstanding.
If earnings remain the same but there is less shares outstanding, we can take for granted that the earnings per share might represent a positive NPV, or if the company reduces their number of shares outstanding, then they could increase earnings per share and also can raise the market value of the shares outstanding. However, if the company decides to authorize a repurchase of shares at the price of the book value per share, arguing that the shares are undervalued, then investors could buy those shares at a very low price.
What will be the effects of issuing $2 billion of new debt and using the proceeds to repurchase shares on:
MCI's shares outstanding?
Shares repurchased at $28,92,ƒœ then 69,16 million shares are going to be repurchased back, leaving 611,84 million shares outstanding.
Shares repurchased at the current price of $27,75, ƒœthen 72,07 million shares can be repurchased and leaves 608,93 million shares outstanding.
If there is no repurchase, then shares outstanding remain between 608,93 and 611,84 million (which are the shares outstanding if they were repurchased) as the repurchase price increases from $27,75 to $28,92 (at a Pre or Post repurchase share price).
MCI's book value of equity?
According to Exhibit 5:
Total Current Liabilities
Long Term Debt
= 3444+2000 = 5444
Deferred Taxes and Other
= 9602-2000 = 7602
Repurchase effect on leverage (using D/E ratio as a measurement, and assuming that D refers to Long-Term Debt):
Pre D/E = 3444/9602 = 0,359
Post D/E= 5444/7602= 0,716ƒŸThis is the increase of the Debt-Equity ratio to "at least" twice 36%.
We have to remember that Phillips suggested that MCI would need to increase its Debt-Equity ratio from its current level of around 36% to "at least twice that", even at that debt level the company's debt-to-cap would be moderate relative to the industry.
Supposing that the debt of $2.000 million is Long-Term Debt (LTD);
According to Exhibit 2:
LTD/ BV (Book Value) of Pre Equity
Then: BV of Pre Equity= LTD/0,359 = 3444/0,359
BV of Post Equity= 9593* 609/681
The price per share of MCI stock?
New market Price= (New VOP - Old Debt)/Old number of stocks
= ($27.537,26 - 3.944) / 681= 28,8
These is the Data:
oldã€€n# of stock
new n# of stock
Old share mkt price
NEW MKT PRICE
old mkt cap. Equity
new mkt cap.Equity
FREE CASH FLOW
Earnings per share?
EPS= Net Income/ Shares Outstanding
Assuming the EBIT keeps stable in 1996:
Using the cost of debt of MCI shown in exhibit 3.
Loan interest level BBB1 Phones based on the interest level of obligations of A1 Phones =((6,26+6,46)/2)= 6,36
Post EPS= (EBIT - (Interest Expense + Debt* Cost of debt))*(1-Taxes)/Post Number of shares
=485,88/609 = 0,80
Using Income statement of 1995 to get the interest rate:
EPS= (Income before extraordinary item - Debt *(Interest expense/Long Term debt)*Taxes)/Post Number of shares
EPS= ($573 - $2000 * ($181/$3444) *0,4)/609= 0,87
Using the estimated EPS in exhibit 2:
EPS= Net Income / Outstanding
= (Estimated 1996 Year End EPS * Outstanding - debt* i * (1-T))/ A- outstanding
= (1,75 * 681 - 2000 * 6,36% * (1-0,04))/609
What is MCI's current (pre repurchase) weighted average cost of capital (WACC)?
MCI'S current WACC =11,88% (See Excel Sheets for explanation)
What would you expect to happen to MCI's WACC if it issues $2 billion in debt and uses the proceeds to repurchase shares?
If MCI issues $2 billion in debt and uses the proceeds to repurchase share, the cost of equity will increase and the WACC is expected to decrease. The higher WACC is due to the higher leverage ratio. In the MCI case, the market value WACC will be decreased from its original 11.88% to 11.53%, it also have higher value of cooperation, the increased value of the firm makes the stock price going higher level. The following table shows the relationship between corporatevalues of the firm versus WACC.
Would you recommend that MCI increase its use of debt? If so, by how much?
Yes, it is recommended. From the below sensitivity test, we can see that the optimal WACC is about 10.79% which means 42.25% debt ratio and 57.75 equity ratio. The debit required is 6381.83million, and the book value of corporate will be increased to 14213.42million. Therefore I suggest MCI issue 2.437billion dollars to increase its debt/equity level and maximize the value and stock price.
By old Book value
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